Thursday, December 26, 2013

Turkey's political stability in question; yield breaches 10%

Turkey's government is in disarray. It is quite common for governments, particularly in countries with an authoritarian leadership (and Turkey's leadership has been acting in that fashion), to blame whatever the mess the country is facing on corruption (see example). And the more the Turkish Prime Minister Erdogan loses grip on power, the more he will blame "corruption" for his predicament. With Erdogan's cabinet reshuffled (see story from NBC), as ministers resign (some of whom are calling for his resignation), Turkey's near-term political stability has been called into question.

The central bank has been desperately trying to defend the lira as the current account deficit can no longer be financed with foreign capital inflows. But selling foreign reserves has been ineffective and a hike in short-term rates may be the next step. However, rising rates may further damage the nation's economy that has been weakened by capital outflows in recent months (see post).

Investors are not taking any chances, with the lira, the stock market, and the country's government bonds all taking a severe beating. The chart below shows the dollar appreciation against the lira as the currency hits record lows. What worries many investors is that renewed weakness in the nation's currency could accelerate inflation, causing further social unrest.

Source: Investing.com

Turkish 10-year bond yield has breached 10%, as the selloff that started a couple of months ago accelerated.

Source: Investing.com

With investors already jittery about emerging markets in the face of tighter monetary conditions and higher rates in the US, the situation in Turkey has become precarious. While the media has not focused on this angle, the situation also presents a significant geopolitical risk, given the regional importance of Turkey, a member of NATO, for the US and the EU.